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29-04-2012, 12:01 PM
The Straits Times
Apr 29, 2012
Keep faith in gold but...
Investors should be mindful of the near-term risk
By Andy Mukherjee
Many investors have been blinded by the glitter of gold, and some are now wondering if they made a mistake by falling prey to the lure of the yellow metal.
My advice to them: Keep your faith.
It's easier said than done. Those who bought gold a year ago, either in physical form or as units of an exchange-traded fund, earned a spectacular 27 per cent return between just July and August.
And then came the drought. By the end of 2011, gold prices had fallen back to where they were in mid-July.
Gold bugs' hopes were rekindled by a 13 per cent rally in the first two months of this year but that, too, fizzled out.
Those who are holding on to the yellow metal are wondering what's going wrong and when the good times for gold will return.
The medium- to long-term rationale behind gold investing is intact. Central banks in developed economies are flooding the financial system with a deluge of paper money. Right now, the global banking network is in no shape to use this additional liquidity to generate private sector credit in a big way.
But when credit demand picks up, the monetary authorities may be unlikely to be able to mop up liquidity before it feeds into expectations of higher wages and prices.
In an inflationary spiral, gold will hold value. Betting on such an outcome is undoubtedly speculative. Hence, investors should park just a small part of their wealth in gold.
A final piece of advice to investors: Don't ignore the near-term risk.
This is where most gold lovers have gone wrong in the past year. They didn't foresee that gold would suddenly become attractive collateral for cash-strapped European banks. These financial institutions badly needed US dollars, which the money market has been wary of supplying them since the European sovereign-debt crisis took a turn for the worse in the final months of last year.
Any bank that needs to borrow US dollars for, say, three months, can always raise the money in the interbank market by lending a valuable, liquid asset for that duration after which it will get back its asset and return the dollars.
Usually, a government bond is the asset used in such transactions. But why would any bank that has crisp greenbacks to give away do so against Spanish or Italian securities? What if the bank borrowing the dollar goes belly-up and the European sovereign debt backing it also loses value? The rise of such concerns in the second half of last year convinced both lenders of US currency and its borrowers that gold was a good alternative.
Even if the entire European banking system collapsed, the gold being pledged would still be valuable, and the lenders of US dollars would not lose money.
Normally, borrowers of an asset pay lenders for getting to use it. But such was the desperation of European banks in early December that they were willing to pay as much as 0.57 per cent a year to anyone in the market who would take gold from them and give them US dollars instead for a month. This curious phenomenon, known as a negative gold lease rate, is publicly available information. (Type 'Libor gofo' in your Internet search engine to see price charts.)
Gold investors must be wary of these negative rates because they represent an artificial debasement of their beloved asset. After all, if banks keep dumping gold to tide them over a temporary shortage of US dollars, the price of the metal is bound to fall. And that is exactly what has happened.
Analysts have also wondered about the source of this gold. Surely, banks in Europe didn't have the metal sitting in their vaults? It must have come from central banks, which own a lot of it.
The bad news for gold investors is that for short horizons such as one month, the gold lease rate continues to be slightly negative - in other words, the metal is still getting lent out too cheaply.
The good news is that, six-month lease rates have doubled in the past month to 0.26 per cent.
Gold investors are turning optimistic. The United States economy created just 120,000 jobs last month, compared with expectations of more than 200,000. If the US Federal Reserve responds to a lacklustre job market - not to mention a moribund housing market - by printing yet more paper money, then gold will do well as a storehouse of wealth.
A word of caution is needed, though. The European Central Bank (ECB) does not seem to favour adding to the one trillion euros of ultra-cheap liquidity that it has flooded the region's banks with since December.
The ECB's inaction, borne out of Germany's abhorrence of inflation and a rise of anti-euro sentiment in France, could hurt gold investors. That's because if Spain ends up requiring a bailout, then there will be panic in the European banking system. The liquidity shortage of Europe's banks will once more turn acute, and they will again be lending out gold to raise cash, putting downward pressure on the price of the metal.
Investors must monitor the gold lease rates carefully and they ought to remember that negative lease rates don't augur well for prices.
While the metal may reward its enthusiasts handsomely over the next few years, it's the next few months that investors need to worry about.
andym@sph.com.sg
Apr 29, 2012
Keep faith in gold but...
Investors should be mindful of the near-term risk
By Andy Mukherjee
Many investors have been blinded by the glitter of gold, and some are now wondering if they made a mistake by falling prey to the lure of the yellow metal.
My advice to them: Keep your faith.
It's easier said than done. Those who bought gold a year ago, either in physical form or as units of an exchange-traded fund, earned a spectacular 27 per cent return between just July and August.
And then came the drought. By the end of 2011, gold prices had fallen back to where they were in mid-July.
Gold bugs' hopes were rekindled by a 13 per cent rally in the first two months of this year but that, too, fizzled out.
Those who are holding on to the yellow metal are wondering what's going wrong and when the good times for gold will return.
The medium- to long-term rationale behind gold investing is intact. Central banks in developed economies are flooding the financial system with a deluge of paper money. Right now, the global banking network is in no shape to use this additional liquidity to generate private sector credit in a big way.
But when credit demand picks up, the monetary authorities may be unlikely to be able to mop up liquidity before it feeds into expectations of higher wages and prices.
In an inflationary spiral, gold will hold value. Betting on such an outcome is undoubtedly speculative. Hence, investors should park just a small part of their wealth in gold.
A final piece of advice to investors: Don't ignore the near-term risk.
This is where most gold lovers have gone wrong in the past year. They didn't foresee that gold would suddenly become attractive collateral for cash-strapped European banks. These financial institutions badly needed US dollars, which the money market has been wary of supplying them since the European sovereign-debt crisis took a turn for the worse in the final months of last year.
Any bank that needs to borrow US dollars for, say, three months, can always raise the money in the interbank market by lending a valuable, liquid asset for that duration after which it will get back its asset and return the dollars.
Usually, a government bond is the asset used in such transactions. But why would any bank that has crisp greenbacks to give away do so against Spanish or Italian securities? What if the bank borrowing the dollar goes belly-up and the European sovereign debt backing it also loses value? The rise of such concerns in the second half of last year convinced both lenders of US currency and its borrowers that gold was a good alternative.
Even if the entire European banking system collapsed, the gold being pledged would still be valuable, and the lenders of US dollars would not lose money.
Normally, borrowers of an asset pay lenders for getting to use it. But such was the desperation of European banks in early December that they were willing to pay as much as 0.57 per cent a year to anyone in the market who would take gold from them and give them US dollars instead for a month. This curious phenomenon, known as a negative gold lease rate, is publicly available information. (Type 'Libor gofo' in your Internet search engine to see price charts.)
Gold investors must be wary of these negative rates because they represent an artificial debasement of their beloved asset. After all, if banks keep dumping gold to tide them over a temporary shortage of US dollars, the price of the metal is bound to fall. And that is exactly what has happened.
Analysts have also wondered about the source of this gold. Surely, banks in Europe didn't have the metal sitting in their vaults? It must have come from central banks, which own a lot of it.
The bad news for gold investors is that for short horizons such as one month, the gold lease rate continues to be slightly negative - in other words, the metal is still getting lent out too cheaply.
The good news is that, six-month lease rates have doubled in the past month to 0.26 per cent.
Gold investors are turning optimistic. The United States economy created just 120,000 jobs last month, compared with expectations of more than 200,000. If the US Federal Reserve responds to a lacklustre job market - not to mention a moribund housing market - by printing yet more paper money, then gold will do well as a storehouse of wealth.
A word of caution is needed, though. The European Central Bank (ECB) does not seem to favour adding to the one trillion euros of ultra-cheap liquidity that it has flooded the region's banks with since December.
The ECB's inaction, borne out of Germany's abhorrence of inflation and a rise of anti-euro sentiment in France, could hurt gold investors. That's because if Spain ends up requiring a bailout, then there will be panic in the European banking system. The liquidity shortage of Europe's banks will once more turn acute, and they will again be lending out gold to raise cash, putting downward pressure on the price of the metal.
Investors must monitor the gold lease rates carefully and they ought to remember that negative lease rates don't augur well for prices.
While the metal may reward its enthusiasts handsomely over the next few years, it's the next few months that investors need to worry about.
andym@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
